The mortgage crisis litigation team at Paterson Belknap Taylor & Webb had their big RMBS putback hearing yesterday in New York Federal Court. It centered on one of the first monolines, Syncora, to highlight the alleged massive securities fraud Bear Stearns and EMC were engaged in when they sold billions of residential mortgage backed securities to Wall Street investors at the beginning of the financial crisis. Syncora’s lawyers at PBWT were asking for the court to allow them more damages if they can prove there was a material adverse effect in their breach of contract case against the Bear Stearns companies now owned by JP Morgan.
At the center of this highly watched legal debate is whether RMBS investors will have to do the costly legwork to prove exactly which loans were losses and how that loss was caused by a breach of contract. In the case of the $600mn-ish security Syncora is arguing over, that equates to digging through around 10,000 loans – which would delay discovery and be a huge financial burden to the a smaller sized monoline. So instead, PBWT’s Philip Forlenza and Erik Haas are arguing if they can prove the whole Bear Stearns RMBS sausage machine was so corrupt and irresponsible the entire due dilly process was knowingly broken and as a result the humpty dumpty of a RMBS they bought can’t be put back together again then the whole damn securities should be repurchased. In legal terms that means they don’t want the judge to make them prove loss causation for each loan and they want a return of all the money they paid out to investors when the RMBS failed.
JP Morgan’s outside counsel Bob Sacks of Sullivan Cromwell hardly challenged the PBWT lawyer’s legal theory about loss causation and instead led a condescending oral argument ‘telling’ Judge Crotty this isn’t an issue to decide til trial. In other words, it was just another kick the can down the road game by JP Morgan because, as I pointed out a few weeks ago, they don’t want to up their RMBS putback legal reserves and take a hit to regulatory capital levels. Sacks, represented the stereotypical, puffy-chested, arrogant Wall Street lawyer Sullivan Cromwell is known to breed, but I was surprised to see him talk down to the federal judge and insult his seasoned experience with lines like, “Your honor how can you decide on this when they haven’t even presented any evidence yet.” Judge Crotty politely reminded Sacks he does have equity power to make this decision and asked once again if JPM/Bear/EMC’s argument is still the RMBS failed because of the financial crisis and not because of a breach of reps and warranties. And Sacks boldly answered, “YES!”
The notion that no evidence has been presented yet in this case is absurd considering PBWT has brought in over 30 whistleblowers and shown internal emails/memos from Bear Stearns telling its staff to not waste money on loan level due diligence. The whole Sullivan and Cromwell oral argument read like an attempt to deflect from the real legal issues on the table because lawyers like Sacks know how serious this is for JP Morgan’s balance sheet if the judge decides in Syncora’s favor. I emailed Sacks after the hearing asking if he’s usually this arrogant when speaking with a Federal judge but surprise surprise I didn’t get a comment.
The mahogany paneled 20th floor court room overlooking a beautiful skyline of lower Manhattan was packed with lawyers from other firms. Presumably all looking to lift legal arguments for their clients who are also suing JP Morgan/ Bear for ,in total, $120bn of mortgage securities violations. San Francisco-based Attorney Isaac Gradman called the Syncora hearing one of the top five to watch this summer writing at his legal blog Subprime Shakeout:
“I’ve discussed at length how important the definition of materiality/loss causation will be to the ease of proof in put-back litigation. No single issue would cause a bigger swing in the pendulum of losses from investors to banks than a ruling that put-backs do not require a showing that the identified breach of reps and warranties actually caused the loan to go into default.”
Judge Crotty actually asked PBWT’s Forlenza why he needs this decision now and Forlenza explained it’s critical so they know how much data and witnesses they will have to gather to prepare for trial.
But in reality this is simply another BIG but important hurdle for the underdog Syncora to win early on so they can force JP Morgan to shell out billions for the sins of Bear’s mortgage traders in a settlement and avoid a trial which isn’t scheduled til next year.
Gradman agrees and told me in an interview this week, “This would be the quickest path to a favorable settlement for the monolines. It’s major leverage if they win this loss causation decision.”
But Crotty’s decision on how investors can win damages against banking giant JP Morgan, if they prove their case, isn’t all about a group of monolines getting billions of lost dollars back. It also hits at the core of investor confidence in the securitization market. Securitization doesn’t have to be the dirty word congress and liberal journalists have made it to be. The markets actually needs it to keep the money chain flowing. The issue is we need securities contracts that mean what they say and more importantly are upheld by the courts when challenged for things like lying to the raters/insurers about the homeowners loan level detail – a fact my reporting and the PBWT lawyers have already shown really happen.
In the view of powerful institutional investors, like Blackrock, the RMBS contract obligations were clear, but the banks simply are not adhering to the bargain. This putback litigation is now all about the banks trying every legal maneuver conceivable to re-write the deal. Question is will conservative federal judges like Crotty allow the banks to do this?
Reuters legal columnist Alison Frankel interviewed Blackrock’s Randy Robertson yesterday who summed up one of the key problems with Judges allowing the banks like JP Morgan to keep kicking the RMBS putback litigation down the road.
“Robertson’s view: Litigation — or, more precisely, the conflict that leads to litigation — stands in the way of an MBS revival because investors don’t believe issuers will live up to contract terms.”
We have no idea when Crotty will make his decision except he said the lawyers will “hear from him shortly”. That could be 10 days or a few months. But if we get a wishy-washy I don’t want to rule now brief from him then it’s back to watching what the more aggressive Judges are doing in New York State court. A judicial system that’s at least shown it isn’t afraid to stand up to big law pompous Wall Street lawyers like Sacks and have already ruled against Obama’s favorite banker Jaime Dimon.
One of the best legal court reports I’ve ever read. Your stark humor and biting truth is a refreshing read.The street knows S&C lawyers are always full of themselves though but it was nice to see someone put that in print. You’re right this case is now about contract law and the lesson is they should have been written with tighter language.
Keep up the great work Teri.